Canadian’s Personal Debt to Income Ratio Reviewed

There was an interesting article in the Globe and Mail earlier in the week as Rob Carrick spoke with CIBC’s Chief Economist Benjamin Tal about the recent focus on Canadian debt levels and how the major indicator, the debt to income ratio, may not be the best tool of measurement. Mr. Tal was quoted as saying, “this is one of my least favourite economic indicators”.

Canadian personal debt levels surpass the US

In December, Canadian household debt to disposable income (income after taxes, EI contributions, etc) ratio reached it’s highest level in Q3 2010 at 148.1% (+6.7% year/year) and surpassed the US ratio of 147.2% for the first time in a long while.

Canadian debt levels have been increasing as interest rates, and mortgage rates, have been at all time lows over that past few years. This has prompted some consumers to take advantage of these low rates and borrow to buy bigger houses with larger mortgages, than they would have been able to if rates had been at “normal” historical levels. This has prompted the Government to tighten mortgage insurance rules that come into effect next month and try and curb Canadian consumer’s recent borrowing habits.

The article went on to argue that this number taken by itself is meaningless and needs to be taken into the right context to be useful. One issue that was cited is that it measures different things that aren’t directly comparable, namely annual disposable (after-tax) income and your total debt level including your mortgage, lines of credit, credit cards, and personal debt. Realistically, most Canadians aren’t expected to be able to pay off all debts with a single, year’s salary.

Useful to compare against your cohorts

Another issue is that it includes everyone – so seniors who are mortgage free, to recent 1st time home buyers – whose ratios would be significantly different. While it’s good for a high-level view, economists use other measures such as how much after tax income goes toward interest payments. This ratio isn’t nearly as bad as the debt to income ratio. The best use of the debt-income ratio would be to see how you compare against people your own age in a similar household situation (if you’re married with 2 kids versus single with no student loans).

It is useful to follow the growth of the debt-income ratio to monitor longer term trends rather than the absolute level. For example, the ratio was 130% before the financial crisis, so the jump has been significant in the last few years. Mr. Tal sees the ratio increasing slowly over the next few years rather than a quick increase as we’ve seen since 2008.

Government urging Canadians to save

The Bank of Canada and the Finance Minister, Jim Flaherty, would like Canadians to revert back to smart savers and start to boost their savings and putting more money into products like high interest savings accounts and TFSA rather than borrowing more money. They’ve been sounding the alarm for months now that interest rates will not stay at these levels forever, and consumers need to start planning for higher interest rates.

Higher interest are good for savers thought, and we’ve just created a new tool to help you figure out the return on your savings. Try out our new savings calculator and see how much you could earn in the next few years.

Related Topics

Debt Repayment / Economic News / Personal Finance / Personal Finance News

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